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Friday, March 13, 2009

Some Thoughts on the Last Four Trading Days

The market has been rather choppy so far with the Dow moving from up 50 to down 30 and everywhere in between. I won't venture a prediction on where it finished, however unless there is a monumental shift, this will be a very good week for stocks all around. So far, the Dow is up about 9% and most averages fall somewhere there abouts.

How did this come about? The market has centered on several pieces on news and formed a "narrative" for the short term. The first bit of news was a leaked internal email from the CEO of Citigroup to staff suggesting that the company had turned an operating profit for the first two months of the year. Right after this, the February retail sales numbers were reported and they were better than expected and just about even. The latest bit of news also comes from Citigroup where their chairman suggests that the company has turned the corner and doesn't expect to need any more tax payer capital. Bank of America also made a similar suggestion. Also, GM reported that they won't need anymore cash for NOW. Now, there has been all sorts of bad news reported as well. There was some bad employment data. A new report showed that foreclosures were up about 30% in February and several Treasury nominees withdrew their names.

That the market latched onto the good news and made significant gains as a result tells me that it was "oversold". Oversold is, in my opinion, overused, however, in this case, I use it specifically because the market latched on to good news and ignored bad news. That tells me that there were a lot more people looking for a reason to buy than to sell. Now, in reality, while oversold seems like a firm level, in fact it is often a very short term dynamic. A level that is oversold one week, can easily be broken through the next week. That's why short term trading is so difficult in the market.

What concerns me much more than the short term movement is some of the drivers of it. I have no reason to question the veracity of the retail numbers, however I do believe they are an anomaly. The same month they were relatively even we lost almost 600,000 jobs. It's unlikely that retail sales will continue to stabilize if we continue to lose this many jobs. It's even less likely that a stabilization in retail sales will lead to a stabilization in jobs. As such, while we have seen a small reprieve, I don't think these numbers are in any way indicative of a trend.

That is not necessarily all that troublesome. What is troublesome is the multiple announcements by Citigroup, Bank of America, and GM. If we are to take these announcements, along with the retail data, at face value, then we might be looking at the most over hyped "crisis" ever. Now, take a look at this opinion piece from earlier in the week.

Here's the problem: Today's true market value of the U.S. banks' toxic assets (that ugly stuff that needs to be removed from bank balance sheets before the economy can recover) amounts to between 5 and 30 cents on the dollar. To remain solvent, however, the banks say they need a valuation of 50 to 60 cents on the dollar. Translation: as much as another $2 trillion taxpayer bailout.

That kind of expensive solution could send the president's approval rating into a nose dive. Consider: $2 trillion is about two-thirds of the tax revenue the federal government collects each year.

The logical alternative -- talk show hosts' solution dujour -- is to temporarily restructure or nationalize the banks and leave taxpayers alone. Remove the toxic assets, replace management and cut the too-big-to-fail financial dinosaurs into smaller, nimbler entities. Then reprivatize these smaller banks and let the recovery begin.

Now, either reality is more like what is presented in this piece or it is more like what the higher ups and Citi and BofA are presenting. The author of this piece is claiming that not only is there a serious solvency problem, but that to resolve it would require the Treasury to overpay for all of these "toxic assets". Both Citi and BofA are saying that they have turned the corner and they won't even need any more capital injections.

Then, there is the issue of the email from the CEO proclaiming the first two months were profitable. The leaked email provided no context and of course it is unclear if it was ever meant for the viewing of the general public. This too seems rather dubious. We don't know if his calculations include any write downs, or if they are simply measured by cash flows. It seems rather hard to believe that into the teeth of a serious recession that this bank would somehow be turning profit. Not but a month before this was leaked, they negotiated for the Feds to inject cash and take over about 40% of the company. Were they really doing this will turning a profit? The stock market was down about 20% in the period in question. With all their investment related divisions, were they really able to turn a profit into the teeth of a serious bear market?

Then, there is GM. Back at the beginning of February, the CEO of GE said that he didn't see any reason why GE would need to cut dividends. At the end of February, GE announced they would need to cut dividends. That's what this announcement reminds me of. Did I miss something? Has GM figured out a way to make money? If not, how long before they need a cash infusion? After all, the last one was supposed to be a bridge until they restructured. I have heard nothing of a restructuring. So, unless I am missing something, GM is going to run out of money rather soon.

I say this because the market suffers from both a crisis in confidence and in credibility. Bankers and CEO's are not to be trusted right now. If they come out and make dubious forecasts only to find out later they were far too rosey, that will boomerang in an awful way once the truth is revealed. If sometime in early April, GM announces they need more money PRONTO, then, that won't only crush GM but the entire market. If the first quarter reveals heavy losses for Citigroup, that would be nothing more than a crisis in confidence and in credibility. It would mean that no one is to be trusted. If no one in the market is to be trusted, then investment Dollars pour out in waves. I can only hope that this short term rally is NOT built on dubious outlooks and predictions because if they are, god help us all when the truth comes out.